Canada's Minister of Finance, Paul Martin, recently released a package of draft income tax legislation regarding measures proposed in the federal government's February 1998 budget. The following briefly summarizes some of the more significant proposals and highlights related modifications contained in the legislation package.
AMOUNTS OWING BY NON-RESIDENTS
The current law can deem interest income be included in the income of a Canadian corporation where funds are loaned at nil or low interest to a non-resident. As part of the budget proposal to extend the application of this existing anti-avoidance rule, an exemption in that rule in respect of non-residents that are first-tier subsidiary controlled corporations has been extended to non-residents that are controlled foreign affiliates.
The budget proposed to amend the tax consequences that follow when a non-resident corporation becomes resident in Canada. These proposals were intended to explicitly limit opportunities to realize Canadian-source surplus in such corporations without paying Canadian tax.
The draft legislation incorporates two refinements of the original proposals. First, where the paid-up capital of the shares of an immigrating corporation is less than the fair market value of the corporation's net assets at the time of immigration, the increase in paid-up capital to fair market value is made dependent on an election by the corporation. If the election is made, a resident shareholder is deemed to receive a dividend, thereby ensuring that the increase in paid-up capital is a tax-paid amount.
Secondly, with respect to the cost of shares of the immigrating corporation, the above-noted deemed dividend is added to a resident shareholder's cost. For a non-resident shareholder, the existing rule reducing the cost of the shares to the lesser of cost and paid-up capital is replaced by a rule which resets cost at the fair market value of the share, but only if the share was not taxable Canadian property before the corporation migrated.
Current anti-avoidance provisions are designed to prevent non-resident shareholders of Canadian corporations from stripping Canadian taxable surplus by selling shares of a Canadian subsidiary to another non-arm's-length Canadian company. These rules are expanded after February 23, 1998 to apply to dispositions of shares of any other corporation resident in Canada and are expanded to also apply to the disposition of partnership interests of which the non-resident is a majority partner. These rules will not apply to the taxable Canadian property on which Canada's right to tax is not limited by tax treaty.
In certain cases, this anti-avoidance rule itself could inappropriately reduce Canadian tax otherwise payable. The budget therefore proposed not to apply the surplus stripping rules in these cases. Legislation to implement this part of the proposal will, however, have to both limit the application of this measure to the intended situations, and foreclose other avoidance techniques. To ensure this balance, the measure will be subject to further study, and will not be implemented at this time.
The budget proposed that non-resident corporations file an information return if they claim a treaty exemption from income tax on their Canadian-source business income for taxation years that begin after 1998. This has been modified to require the information to be included in the corporate income tax return.
LARGE CORPORATIONS TAX
The budget proposed that the corporations that are prescribed to be financial institutions for the purposes of the Large Corporations Tax be treated as specified financial institutions for income tax purposes. Thus, they would be required to use the "mark-to-market" rules for securities.
However, the draft legislation excludes certain corporations from the definition. Where a corporate group establishes a separate corporation to buy trade receivables from the operating companies in the group for the purpose of either collecting the receivables or selling them to third parties, it is not intended that the operating companies, for that reason alone, be treated as specified financial institutions for the purposes of the Income Tax Act. It is therefore proposed that such an operating company be treated as a specified financial institution unless the company to which it is related is a captive factoring company that is either a prescribed financial institution for the purposes of the Large Corporations Tax, or a company having as its principal business the lending of money or the acquisition of debt from arm's-length persons.
Self-employed individuals will be allowed to deduct premiums for private health service plans covering themselves, their spouses and household dependants. Deductions will only apply to the tax years starting after 1997 where they are actively engaged in the business and the business is their primary source of income or their income from other sources does not exceed $10,000. As originally proposed, the deduction was to only apply if coverage was provided to all permanent full-time arm's-length employees. The draft legislation will allow restricted deductions in cases where there are no arm's-length employees or where less than 50% of employees dealing at arm's-length are extended coverage.
The budget proposed that deductible moving expenses would include certain costs of maintaining a vacant former residence (including mortgage interest and property taxes). The deductibility of these expenses was to be limited to the least of the following amounts: the actual amount of the maintenance expenses, the portion of the expenses attributable to a period of three months, and $5,000. The three-month limitation has been eliminated from this proposal.
The budget also proposed changes to the tax treatment of amounts paid by employers for a loss on a sale or loss in value of a former residence and for higher mortgage interest payments at the new location. The draft legislation has postponed the coming into force of these measures, which were originally to apply to relocations effected after June 1998. For relocations in which an employee commences work at the new work location before October, the new measures will not apply until the 2001 and subsequent taxation years. For all other relocations, the new measures apply to 1998 and subsequent taxation years.
ALTERNATIVE MINIMUM TAX
Deductible contributions to registered retirement savings plans and registered pension plans (including those in respect of severance received) will no longer be considered preference items for alternative minimum tax ("AMT") purposes, retroactive to 1994.
MUTUAL FUND TRUSTS
The budget proposed that mutual funds trusts be allowed to elect to fix their annual distributions of taxable income within one month after the year. If made the election would also apply to the earlier year of unitholders for purposes of calculating their taxable income and adjust cost bases.
The draft legislation does not deal with the year-end distributions of mutual fund trusts. Concerns underlying these proposals have been discussed with the mutual fund industry over the last few months. Further to these discussions, the Minister of Finance announced that mutual fund trusts will generally be permitted to elect to have a December 15 year-end in order to minimize difficulties in the timely calculation and reporting of distributions to unitholders at year-end. It is expected that legislation to implement this new proposal will be tabled before the end of 1998.
The Finance Minister confirmed that the government intends to proceed with proposals relating to taxpayer migration first announced on October 2, 1996. Detailed proposals are expected to be released later this year.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
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